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Facing Up to Pension Underfunding

Recent moves by big companies to bolster their defined-benefit plans indicate they are waking up to the fact that while last year's market rally helped, on average, plans ended 2010 considerably short of full funding. Just last week, General Motors contributed $2 billion worth of company stock to its DB plan, which it had announced last fall, and AT&T said it was changing its pension plan accounting.

Plan sponsors "are coming to accept that the market is not going to come rushing back to their rescue and that they are going to have to make some contributions over the next several years," says Jon Waite, chief actuary and director at SEI, an investment solutions provider in Oaks, Pa.

Companies are also "taking a more active role in the management of their plans," Waite adds, noting that a decade ago many plans were on autopilot. "Plan sponsors have seen over the past few years how these plans have had a dramatic impact on their corporate finances," he says.

General Motors has said it wants to get its pension plan to full funding by 2013 and then start bringing its assets more into line with its liabilities by investing more in fixed-income securities. The $2 billion worth of stock it put into the plan last week follows a $4 billion cash contribution it made last fall.

GM's pension plan is bigger than the company, "so small swings in the plan have an enormous impact on the company," Waite says. "I think they're looking at, 'Let's fund it up and get rid of all the risk in the financial engine that is driving General Motors.'"

Similarly, Exelon said earlier this month that it would contribute $2.1 billion to its plan in the current quarter, and Honeywell announced last fall that it would contribute $1 billion to its plan in both 2010 and 2011.

AT&T said it will start reporting the fair value of the plan's assets, instead of smoothing those changes. Waite notes that investment analysts often look beyond such smoothing when they examine a company's results. And as a global company, AT&T has to deal with international accounting rules that allow less smoothing than GAAP does, he says.

A&T is also cutting the discount rate, which is used to measure the plan's liabilities, to 5.8% from 6.5%. As a result of the changes, AT&T will cut its retained earnings by $17 billion, resulting in a $2.7 billion non-cash charge to its fourth-quarter earnings. AT&T said the changes are aimed at making its results more transparent.

Consulting and actuarial firm Milliman says its index of the 100 biggest defined-benefit pension plans shows their funding liability grew by $49 billion last year as the increase in plan liabilities resulting from lower interest rates outpaced the growth in assets as markets rallied. Milliman put the average funded status at the end of 2010 at 79.8%, down from 81.9% at the end of 2009.

Other estimates of the funded status of big plans are a bit rosier. For example, Moody's estimates the 50 biggest nonfinancial company pension plans improved to between 85% and 89%, from 79% at year-end 2009.

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